IndefeasibleRightsofUse

An indefeasible right is one which cannot be annulled or made void. That’s the theory, but the recent spate of insolvencies in the telecommunications industry has called into question how watertight an indefeasible right of use really is.

An indefeasible right of use (or IRU) is a contractual right to use particular fibre(s), cable or perhaps a duct. The IRU became commonplace in the 1980s, when the consortium formed by international network operators to lay subsea cables would grant long term usage rights to its individual members. Typically these interests were granted for 25 years, the reasonable life expectancy of a subsea cable. Since then, the IRU has become shorthand for a long lease of telecoms infrastructure. Given the costs of constructing one’s own network, IRUs have developed over time to become a cheaper means of connection than paying for the rolling out of an entire network.

Usually structured as a 15 or 20 year right, the convention is that the grantee pays a one-off upfront premium and thereafter monthly or annual ongoing maintenance costs. However, unlike the early IRU granted by a consortium as a usage right to one of its members who also had a property right in the consortium, modern IRUs can be 'sold' on a commercial basis to any operator.

The term “indefeasible” would suggest some very considerable legal right, perhaps reflecting the significant sums paid to acquire IRU rights. The orthodox market perception has been of a right akin to an ownership right in the fibre or cable concerned. The fallout in the worldwide telecoms market has led to a realisation that this view is probably incorrect.

Put simply, the IRU details a supply between a supplier (grantor) and a customer (grantee) and confers, at least as a matter of English law, a mere contractual right to use the fibre and to connect its equipment to the fibre at a point of presence (or PoP). IRUs granted to date have tended to follow the form of similar arrangements in the US where this form of agreement was developed.

Because no proprietary right in the fibre accrues (at least in a typical IRU contract), should the grantor become subject to some form of insolvency procedure, the grantee faces the risk of losing its entire capital investment.

The insolvency practitioner appointed to run the grantor company will try to sell its cable or network free of the IRU “rights” of the grantee who is likely to rank only as an unsecured creditor in the grantor’s ultimate liquidation.

Situation outside the UK

The same legal analysis may be made regarding the case in which the IRU is granted by a French supplier who goes bankrupt. In that case, provisions of the French Commercial Code governing bankruptcy shall apply to the agreement. If it is decided to continue the supplier's business, the appointed judicial trustee can decide against the continuation of the agreement. It is very likely that he will opt out of the agreement in order to be able to ultimately sell the grantor's network asset free of the IRU "rights". In that case, the grantee shall only be entitled to damages if it can prove that the termination of the agreement breaches a contractual provision which grants a usage right for a determined term. Even if the grantee is awarded damages by the judge, the claim for damages does not benefit from any privilege (the grantee shall only declare its claim for damages in the grantor's ultimate liquidation as an unsecured creditor). In the event that the grantor's network assets are sold in a transfer plan, the only agreements that the buyer shall continue are the agreements deemed necessary to the buyer's activity and designated in the judgement ordering the transfer . Again, it is likely that the IRU contracts will not be continued by the buyer.

Issues discussed in this article also occur in the Netherlands. There are even certain specific circumstances that accentuate the difficulties that can arise, and in fact are arising in practice, when a contractual party that has conceded an IRU is in danger of going bankrupt. The source of these difficulties is the enduring dispute whether or not telecommunications cables are to be considered as real property. The Dutch Supreme Court is expected to resolve this issue, but it is unknown when. In practice cables have often been transferred or secured as ""movable goods". Transactions with cables and the vesting of security rights on cables are, or rather seem, easier if they are considered to be movable. More importantly, qualification of cables as movable goods could avoid paying substantial taxes on real property and transactions with real property.

If cables are held to be real property, as the Court of Appeal in the Hague already has, the legal position of market parties to whom cables have been transferred or who have obtained a security right on cables may be very questionable especially in the event of bankruptcy of the provider, in the event that only the formalities pertaining to movable goods were fulfilled. Even the contractual right to require that the formalities for real property are fulfilled, will not be sufficient in the event of bankruptcy.

For those market parties who prefer to prevent rather than to cure, there is no need to wait for the Dutch Supreme Court's decision. There are possibilities under Dutch law to ensure that an IRU will survive the other party's liquidation. However, whether this is possible will depend on the specific circumstances and the exact stipulations agreed upon.

In Sweden, IRUs are typically simply contractual rights, and as such they are extinguished on the sale of the asset by the owner, or the bankruptcy of the owner. If there is a sale of the asset the vendor is under a duty to include the grantee’s rights in the contract for sale. However if this is not done, and the vendor has little or no money, the right to damages may be worthless, much as would recourse to a bankrupt grantor when the grantee’s rights are extinguished. Similarly in Sweden no proprietary right arises in typical IRU contracts. However the Swedish Parliament is beginning a consultation on how to update the law in this respect.

Liquidation

Liquidations of insolvent telecoms companies have to date produced at best nominal dividends for unsecured creditors, often a couple of years or more down the line, principally because of the significant debt invested in the networks by lenders (often through a mix of bond and syndicated bank debt) which will be secured and rank ahead of unsecured claims.

The position of an existing grantee on a standard IRU is, in principle, quite straightforward. It needs to hope that its grantor remains solvent and honours the rights granted. With this in mind, what can a prospective grantee of an IRU look to do to mitigate the risks it faces in leasing capacity from others in such an uncertain world? This question gives the opportunity to evaluate what options might be available to structure the grant of rights in a less legally risky way. As will be briefly examined, none of the obvious options are free from drawbacks.

Payment Terms

A deceptively simple suggestion is one which recommends that, rather than pay for an IRU upfront, the grantee should negotiate to pay in instalments over a period. This reduces the credit risk posed by the grantor to the last payment when services or access have not been delivered according to the contract. This type of payment structure is beginning to appear in the industry, but it has drawbacks. It may interfere with the accounting benefits from an upfront fee structure (though of course this whole area is under close scrutiny from a regulatory perspective). Indeed, it is likely not to be commercially feasible for a grantor which is rolling out a network and needs significant initial financial input while it is building up a customer base to service what is likely to be a multi-million pound construction debt.

Take Security?

Another option would be for the grantee to take a guarantee or security to safeguard against the grantor’s insolvency and inability to comply with the terms of the IRU (such as in providing access to the fibre itself and to the collocation sites, maintenance services etc). Though this would not guarantee that the particular fibre would be available for use, upon a triggering event the grantee could look to the guarantor to pay the guaranteed amount in compensation or for secured assets to be sold (such as through the appointment of an administrative receiver) and the net proceeds applied in reduction of the relevant debt. It is sometimes the practice in Sweden for the grantee to take a put option over the network which would be triggered in the case of contractual default by the grantor.

Neither of these options may be viable in practice. A company connected to the grantor is unlikely to represent good value as a guarantor, whilst most telecoms providers are so saddled with secured debt that they will not have any scope to grant security to a mere commercial customer (and probably would not choose to do so anyway).

Transfer of a Proprietary Title

If, instead of a mere contractual right to use a cable or a fibre within it, the grantee could acquire a proprietary interest in the cable or fibre, then its rights as owner should be much stronger and safer. However, this approach too is riddled with legal conundrums beyond the scope of this article. Were an operator to seek to take a transfer of individual fibres, the following list highlights some of the issues which could be expected to arise.

does the grantor own the fibre (realistically the cable) outright or might the original supplier or a security holder have rights, such as under a reservation of title provision or charge?

can an individual fibre strand within the cable be adequately identified?

what is the relationship with other co-“owners” and/or lessees of fibre, in terms of inter-dependability and apportionment of maintenance obligations and mutual benefits?

what about the interaction between other parties involved in a link, such as the landowner and any other occupiers of the land (whether on which the ducts are located or at the PoPs), the grantor/seller and lessors of equipment on the site?

are Code Powers under the Telecommunications Act 1984 available to further secure the operator's ability to continue running its network in the event of the grantor's insolvency and potential break-up

whether the fibre itself is a chattel or would be deemed to form part of the land itself, or a fixture, and the legal implications

what happens if the grantee itself becomes insolvent?

how should any transfer be structured given that the “right to use” is probably only for a limited period?

In Sweden a route has emerged in practice through which the grantee takes a security transfer of the network from the owner. Ownership of the network only reverts if the contract is successfully completed. However, much as in the UK, this is complicated from both technical and taxation points of view.

Conclusions

We have already seen the demise of several telecommunications carriers such as 360networks, the US parent of Global Crossing, and Viatel. Given the current state of the global telecommunications market we have probably not yet seen an end to the casualties.

As a result there are companies who will have entered into IRU’s in the belief that they have secured rights for the next ten to fifteen years but who, without knowing it, are close to losing benefits for which they may well have paid millions of pounds.

The message to these companies is clear. They need to address the questions raised above at the earliest opportunity. Otherwise, the financial consequences may be very painful.